For years, since the enactment of Section 5-322.1 of the General Obligations Law, it has been known that an upstream party to a construction contract, such as an owner or a general contractor, cannot require a downstream contractor to indemnify the upstream party for its own negligence. The rationale is that the upstream party should not, through the use of greater bargaining power, be able to require the downstream party to serve as a substitute for its own insurance carrier. In such a situation, the upstream party would suffer none of the adverse consequences typically associated with its own negligence, such as having to incur the loss or place a claim against its insurance policy—and the consequences typically associated with a claim, such as having to pay a deductible, having the loss present on a loss run, and having its future rates take the loss into consideration and impact its ability to renew (or obtain a replacement for) the policy.
When the legislature enacted Section 5-322.1, it left a significant loophole open: the situation where the construction contract requires the downstream contractor to procure insurance and name all upstream parties as additional insureds on the downstream party’s insurance policy and insure and hold them harmless for all claims arising out of the downstream party’s work, including claims arising out of the that upstream party’s own negligence. This is a narrow loophole because, generally, when the claim arises out of the downstream party’s work, it is, at least in part, due to the downstream party’s negligence (or the negligence of one of its subcontractors). However, the recent case of Burlington Insurance Co. v New York City Transit Auth. (132 AD3d 127, [1st Dept 2015]) highlights that the loophole is not merely theoretical.
In Burlington, the named insured was the tunnel borer working for the NYCTA on a subway construction project. The construction contract required the tunnel borer to name the NYCTA and the lessor/owner of the property on which the project was located (which happened to be the City) as additional insureds on its general liability insurance policy, and to and have that insurance carrier hold them harmless from all claims arising from the borer’s work. The contract also required the NYCTA to identify all underground hazards, including buried pipes, cables, etc.
During the project, the tunnel borer bored into a live buried electrical cable, which caused an explosion and a serious injury to borer’s worker. Clearly, the borer had no way of knowing that it was boring into an unmarked cable and, therefore, cannot have been negligent. The NYCTA, on the other hand, was negligent in failing to identify hazard for the borer (and also breached the construction contract in that regard).
Both owner and the NYCTA were additional insureds under the borer’s policy, as was required under the construction contract. Upon the making of the claim, the borer’s carrier accepted the tender of owner’s defense and indemnification. The borer’s carrier also initially accepted the tender of the NYCTA, but only under a reservation of rights. The borer’s carrier later disclaimed as against the NYCTA when it came out that the borer was not negligent. The borer’s carrier ultimately settled the injured worker’s lawsuit on behalf of the owner for $950,000.
When the dust settled, the borer’s carrier, as subrogee of the City/owner, sued the negligent NYCTA to recover the monies it expended in settling underlying personal injury claim. In doing so, the carrier noted that the proximate cause of the accident was the NYCTA’s negligence in failing to mark the cable. In response, the NYCTA counterclaimed for coverage under the borer’s insurance policy.
After discovery, the parties moved for summary judgment. The trial court granted summary judgment to carrier, holding that the NYCTA, as the negligent party, owed it common law indemnification. The Appellate Division, however, reversed. In doing so, it held that the construction contract required the borer to procure insurance covering the NYCTA for all claims “arising out of” the borer’s work. Clearly, although the borer was not negligent, the injury arose out of its work—certainly, had the borer not been boring in that particular location, the accident would not have happened. Accordingly, since the injury “arose out of” named insured’s work, the additional insured NYCTA was entitled to coverage—even though it was solely negligent. Further, because an insurance carrier cannot seek subrogation from its own insured (even an additional, as opposed to a primary insured), the carrier here could not seek to recover its loss from the truly negligent party. In other words, the NYCTA—the sole negligent party—was held completely harmless for its own negligence by the borer’s insurance carrier. So, while the NYCTA got off scot-free, and although the borer could not be required to directly indemnify the NYCTA for its negligence, the borer had to suffer with a $1 million loss on its loss run and the corresponding increase in insurance premium (and difficulty in obtaining renewal coverage).
The lessons to be learned here are that the loophole is not merely theoretical, and that although a non-negligent party cannot be forced to directly indemnify a negligent party for such negligence, it can be required to procure insurance that would cover that negligence with no consequences to the truly negligent party—and suffer the resulting effects of having to do so. Various trade organizations are currently lobbying the state legislature to close this loophole. In the meantime, it would be advisable to consult with experienced construction counsel to review your construction contracts while they are still in the negotiation stage to try to tailor the insurance provisions so that they only cover situations arising out of the contractee’s negligence.